Harvard 2014

ESG factors take centre stage in the evolving world of the fiduciary

The modern responsibilities of the fiduciary investor extend beyond what are perceived as the “mainstream” investment issues to those related to environment, society and governance (ESG) factors. But there is a growing understanding among fiduciaries that ESG considerations are now equally important in discharging their obligations.

David Wood, adjunct lecturer in public policy and director of the Initiative for Responsible Investment (IRI) at Harvard University’s Hauser Institute for Civil Society, told the Fiduciary Investors Symposium (FIS) at Harvard University that fiduciary duty has historically evolved in-line with the changing investments of funds.

“Examples people always give is they say, well, back in the day a pension fund could only be in bonds; then we opened up to the stockmarket; then we went into alternatives; and fiduciary duty evolved to respond to the changing nature of the market,” Wood said.

“But I think the discussion has changed a little bit, and I think when people talk about the evolution of fiduciary responsibility now, Cambridge University Press has a 1000-page book that’s just on the evolution of fiduciary responsibility and [the evolution] is very much linked to three things”.

Makers of markets

“The first, and this is something that Jaap [van Dam, managing director of strategy for PGGM] said yesterday, and the panel session [on developing a communiqué to the G20 Leaders’ Summit], is the idea that investors should be makers of markets rather then takers of prices. There’s some sense that the era of fiduciary capitalism requires a different role for investors. In fact this is the topic that John Rogers, who used to run the CFA Institute, has just been publishing about.

“Second, I would say that people are linking this to a broader set of contexts in which you evaluate your investment – beyond volatility and price, looking at large environmental and social macro-trends…and especially climate risk has been a big driver of this discussion.

“And then finally – and this is something that Abdallah [Nauphal, chief executive and chief investment officer of Insight Investment] said this morning – is there’s a changing perception of the social role of investors in the world, and that post-financial crisis the way beneficiaries view funds, the way society views funds has changed, and fiduciary responsibility may adapt to that.”

Wood said that within these “big macro contexts” investors have to respond to what they have to do with their portfolios, to adapt to this new way of looking at the world.

Chris Davis, director of investor programs at Ceres, said that “ESG issues such as climate change and other environmental and social variables…have traditionally been considered extra-financial risks”.


“That kind of implies they don’t matter financially, that they’ve social issues or somehow extra-curricular to the serious business of investing,” he said.

“But I think this is no longer true. The world is changing and economies are changing and things are becoming more complicated and life is becoming more risky. ESG failures and incidences can destroy value.

“We define sustainable investing as investing that meets the needs of current beneficiaries, without compromising the ability of the fund to meet the needs of future beneficiaries – sustaining the fund’s ability to sustain returns and meet its multi-generational obligations by taking a longer-term perspective and looking at a wider spectrum of risks and opportunities.”

Davis said this demands that fiduciaries adapt and consider a wider range of factors as the world changes and new risks emerge to confront companies and markets and economies.

“The International Energy Agency has said that in order to limit climate change to 2 degrees Celsius of average warming – which is thought by many to be the threshold between acceptable impacts and impacts that are very hard to manage – will require $1 trillion of additional investment a year, globally on average, between now and 2050,” he said.

“So there’s a huge need to invest in these solutions. That demand for capital is going to create huge economic opportunity in terms of new technologies and new strategies.

Full suite

“How could you be a prudent fiduciary and ignore variables that affect the performance of businesses and the performance of investments? You need to take into account the full suite of relevant information on both the risk and the opportunity side. The solutions to some of these issues – governmental policy responses – are going to create great opportunities.”

Anne-Marie Fink, chief investment officer of the Rhode Island Employees’ Retirement System, said factoring in ESG issues “is a huge challenge”.

“It certainly is an issue and there are concerns, and we do want to watch what’s going on in terms of the longer-term sustainability of investments,” she said.

Fink said the Rhode Island system has more retirees and inactive members in it than active members, and at the current rate of drawdowns the system has a life expectancy of about 13 years.

“It does mean there is a finite period of time we need to think about, and for me fiduciary responsibility is first and foremost generating returns for our pension participants,” she said.

“Most of these issues are things that will play out over the longer term, whereas return expectations, us getting evaluated relative to other states, et cetera, it’s probably shorter-term timeframe. That being said, though, we do want to know what the managers are doing, and do believe very much in sustainability in terms of performance.”

Good versus evil

Brian Clarke, an executive director of IFM Investors, said it was a mistake to think that incorporating ESG factors in to the duties of fiduciaries came down to a “good versus evil conversation”.

“It is not a good versus evil conversation with us at all,” he said.

“It is good management. It is making more money. It posits a very simple equation: if you don’t pour oil in the back of your yard, and you don’t then end up having to clean it [and so on], you’ve going to make more money.

“If you play out all the ESG considerations and implement that across your portfolio, in a fundamental way you’re going to make more profit. When I say ‘in a fundamental way’, it truly has to be an embedded concept.

“We started this process 10-plus years ago, thinking about the conflict between fiduciary responsibility and the desire to have good ESG policies. And over 10 years we’ve come to understand that they are one and the same, first and foremost; and that it’s not about having an ESG policy that stands alone, it’s about having thoughtful ESG considerations in everything you do.”

Clarke says every one of IFM’s investment directors must ask potential target companies about ESG issues upfront.

“It’s part of the DNA of a deal team,” he says. “And then that has to be embedded in how we manage it.”

Clarke says IFM decided to work with one of its investee companies – a water supply business in the UK – to try to cut its carbon footprint by 50 per cent in a year. The project involved all employers, contractors and suppliers to the business, and it hit its target.

“The playout beyond the carbon reduction was the efficiency factor of the company dramatically jumped up,” he said.

“The cost associated with the operation of the company dramatically reduced. EBITDA dramatically increased. Revenue and profitability of the company was significantly enhanced.

“You don’t have to be a rocket scientist to figure it out.”

This article was edited on October 31 to update the name of the Hauser Centre for Nonprofit Organizations to the Hauser Centre For Civil Society, a change of name that took place on July 10 2014.

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